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December 9, 2011

Soros Gambles Big on European Debt

Buys $2 billion in bonds from Corzine's Failed MF Global

The fact that George Soros took his investment firm private earlier this year may be the factor that potentially allows him to score big on a $2 billion bet: European bonds purchased from MF Global Holdings Ltd., Jon Corzine's now-bankrupt securities firm.

Of course, Soros (left) is gambling his reputation, as well as money, on the possibility that the eurozone will succeed in avoiding defaults by the time the bonds mature at the end of 2012.

MF Global, before declaring bankruptcy on Oct. 31, had made its own big bet on European bonds, accumulating some $6.3 billion in short-term debt from Italy, Spain, Portugal, Belgium, and Ireland—some before Corzine even joined the firm. During the summer of 2011, however, according to a Wall Street Journal report, the staggering amount of debt in a steadily weakening economic environment spooked investors and drove the firm into bankruptcy.

This was despite the fact, according to testimony from Jon Corzine in a congressional hearing Thursday, that the bonds were held via "repurchase transactions to maturity" (RTMs or repos) that, according to Corzine, actually reduced the risk of holding the securities outright.

Said Corzine: "Financing the purchase of debt with RTMs allowed MF Global to reduce certain kinds of risk. Because RTMs financed MF Global’s purchase of the debt security to the security’s maturity, the RTMs eliminated the risk (referred to as ‘financing risk’) that at some point during the life of the security MF Global would not be able to find additional financing for the security, and would therefore be forced to sell the security, potentially at a loss. Elimination of the financing risk meant that MF Global’s market risk (arising from the fluctuation of the price of the underlying debt security) was significantly reduced."

Investors did not share Corzine’s confidence, and as the situation in Europe worsened, ratings companies and regulators also grew alarmed. Finally the company shut its doors after laying off a whole division. Corzine resigned, and, as reported by AdvisorOne, in his testimony before Congress admitted that he did not know the whereabouts of hundreds of millions of dollars in client funds.

Prior to its bankruptcy declaration, the firm had sold off approximately $1.5 billion in sovereign debt, but at the time it declared bankruptcy, MF Global still had $4.3 billion in bonds left. Those were turned over to KPMG, which is MF Global's bankruptcy administrator in London, and subsequently offered to large investors; sales were handled by MF Global's London clearing house, LCH Clearnet.

Many investors declined the opportunity, but Soros and his investment team at Soros Fund Management purchased $2 billion in bonds at below market price. The move may already have paid off, since the

yield on Italian bonds fell earlier this week to below 6%, the first time since October it has done so, and European Union leaders seem determined to wrest the debt crisis under control.

During his testimony, Corzine said, "At the time that MF Global entered into the transactions, I believed that its investments in short-term European debt securities were prudent. MF Global invested in RTMs with respect to the debt of Belgium, Italy, Spain, Ireland and Portugal. The first three of these—Italy, Spain and Belgium—were rated double-A or better when MF Global invested in them. Even today, they are all at least single-A rated, and some of them are double-A rated."

He may be right. But Soros, not Corzine, may be the one to get the payoff in the end.

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